South-Western College Publishing - Economics  
Duty-Free Sales No Longer Free
Subject Market Intervention Taxes
Topic Government and the Economy
Key Words Duty, Tax, Harmonization, Price, Sales, Jobs, Revenues
News Story

The European Union has now ended the fifty-year-old practice of allowing cigarettes, alcohol, cologne and other goods to be sold free of duty to air and sea travelers within the European Community. The justification is that the tax break benefited those who travel a lot, such as well-to-do businesspeople, and was inconsistent with the principle of tax harmonization.

Although many people took short ferry trips from England to France mainly to buy cheaper goods just before the policy changed, the reaction of consumer groups has been relatively muted. While duty could amount to as much as 75 percent of the price of alcohol and cigarettes, the duty-free shops did not reduce their prices accordingly.

The Scotch Whisky Association predicts that scotch makers will lose $215 million in sales each year, and that 1,000 jobs will be lost. Ferry companies are also likely to lose out because over half of duty-free sales occurred on ferries. Eventually, airports and ferry companies are expected to find other ways of increasing revenue, such as by attracting more varied stores.

(Updated August 1, 1999)

Questions
1. The restoration of duty can be treated the same way as a per-unit sales tax.
  a) Draw a price-quantity diagram of the market for scotch whisky. Add the demand and supply curves and mark the equilibrium price and output in the absence of duties.
  b) Now that duties are being levied, which curve has shifted? Why?
  c) Illustrate the effect on the price and output of whisky.
  d) The news story reports that the difference between the duty-free price and the free-market equilibrium price was never as great as the size of the duty would imply. Explain why this was the case with reference to the diagram.
  e) Whisky makers may lose $215 million a year. Mark their new revenue net of taxes on your diagram. Explain why the loss of revenue occurs.
2. Ferry companies are expected to suffer.
  a) Draw a diagram of the market for ferry trips, showing the initial equilibrium.
  b) Show what happened to the equilibrium price and quantity of ferry trips when duty-free purchases were banned on journeys within the European Union.
  c) Why was the curve that moved in the case of the ferry trip market different from that which shifted in the whisky market?
Source Thomas Grose, "Duty-free sales end for Europe," USA Today, June 29, 1999.

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